Thursday, March 27, 2008

India's forex must find a better use

NEW YORK: India has wasted three years debating a modest proposal for diverting some of its foreign reserves to plugging the country’s abysmal infrastructure deficit.

It’s only now when China is all set to carve out $200 billion from its reserves into a sovereign wealth fund that India is hastening to reach a decision on what to do with its own low-yielding cache.

Finance Minister P Chidambaram said in a speech at the London Business School last week that the government has “persuaded” the Reserve Bank of India to lend $5 billion from its $212 billion kitty.

The money will go to a special-purpose vehicle formed last year to enable long-gestation projects to raise funds cheaply. India urgently needs to boost investments in roads, ports, airports, power stations and railways. The latest official estimate puts the amount of funds required in these areas at a massive $475 billion over five years.

Better balance

Bloated order books bear testimony to serious supply constraints. Bharat Heavy Electricals, India’s biggest maker of power equipment, has a three-year order backlog. Pakistan’s cement makers are hoping to benefit from a shortage of building materials in India.

All of this provides a perfect setting for spending a few billion dollars from foreign reserves to import turbines, railway coaches, port equipment and air-traffic control systems. With adequate leverage, even $5 billion can have an amplified impact on a $1 trillion economy. India Infrastructure Finance, the special-purpose vehicle, can then have a significant corpus to provide credit lines to companies that will import capital goods.

Spending foreign reserves at home may shore up domestic liquidity and inflation, utilising the funds overseas will help the economy achieve a better balance between strong demand and tepid supply.

At $65 billion, the annual trade deficit is both large and widening. However, that shouldn’t deter the country from accelerated machinery imports. India’s basic balance of payments, or the sum of net exports of goods and services and foreign direct investment, is quite healthy.

The minuscule $1.2 billion shortfall in the year ended March 31 was only a third as large as in the previous year. Those who support the plan to make use of reserves emphasise the low returns on the central bank’s foreign assets, which are financed by selling high-cost local debt.

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